What’s Really Missing from this Economic Recovery

By Michael Lombardi, MBA Published : April 28, 2011

For many years, the backbone of the U.S. economy has been the housing market. I’m not talking during the recent boom years in housing of 2003 to 2006; I’m talking way back. For those of us that lived through it, the housing boom of the late 1940s and early 1950s was a major contributor to U.S. economic growth after World War II.

The energy crisis of the 1970s, the high interest rates of the early 1980s…it seemed nothing stopped the housing machine. Millions of American people, from construction workers, to real estate agents, to mortgage brokers, were happily employed directly or indirectly by construction.

It was President Jimmy Carter’s Administration that started pushing for the dream every American could achieve: home ownership. The Bill Clinton team carried that torch.

Today, despite the most affordable housing market in a generation (when gauged against income), homebuilders are failing miserably at attracting buyers. According to the National Association of Realtors, the housing affordability index in the U.S. is at its highest level in four decades.

But why would Americans buy homes? According to data-compiler CoreLogic Inc., 11 million U.S. homes are worth less than their mortgage. Another two million homeowners have less than five percent equity in their homes…pay the real estate commissions and expenses on a sale and they’ll be underwater, too (the five-percent price decline I’m expecting this year in U.S. housing prices will definitely put them on the negative side).

Hence, we have about one-third of U.S. homes worth less than their mortgages. The median price of a U.S. home has fallen 32% from its 2006 level—the biggest five-year drop in history.

But, have no fear; the government is here.

Two government-created agencies, Freddie Mac and Fannie Mae, which either owned or guaranteed half of all U.S. home mortgages, failed during the credit crisis. The government took them over directly. Hence, our government owns or guarantees half of all U.S. residential mortgages. How ridiculous is that? Imagine how poor the housing market would be if the government was not involved in it.

I’ve lived through many booms and busts. I’ve never seen an economic recovery that did not include housing. With long-term interest rates rising, with such a large inventory of foreclosed homes, and with some many homes “underwater,” how can a real economic recovery happen? This is my point and this is one of many reasons why I’ve been calling it a bear market rally all along.

Michael’s Personal Notes:

The more time that passes, the more I’m convinced that money in Washington is spent with little or no regard to our spiraling debt. It’s remarkable that Americans, as citizens, have not made the debt crisis a national issue.

Estimates I have seen on the Barack Obama Inauguration Day are in the $200-million range. Yes, $200 million of taxpayer money gone for a one-day event. For Libya, the Administration estimates that the cost has been about $600 million so far and is running another $40.0 million monthly. Back in 2008, the Washington Post pegged the cost of the Iraq war at $3.0 trillion. The Afghanistan war could be in the $500 billion to $1.0 trillion range.

Hence, when we hear that our deficit for the year will be $1.5 trillion to $1.6 trillion, we must remember that extraordinary events, like wars and sharply higher interest rates, are not included in the figures.

If the government does not exercise accountability, then the only way to finance its out-of-control debt is to issue more and more debt securities such as U.S. Treasuries. In light of a weakening U.S. dollar, foreigners might buy those securities if interest rates are attractive. The Fed might buy them, too, if it can print more money. The first evil—higher interest rates—chokes the economy. The second—printing more money—sets off inflation. We’re damned any way we look at it.

Where the Market Stands; Where it’s Headed:

Immediate-term, the bear market rally continues. I see five percent to 10% of upside potential from where the Dow Jones Industrials sits today. Short- to long-term, I’m decisively bearish.

After 30 years of falling long-term interest rates, the trend has reversed and we are at the beginning of a new cycle where interest rates will rise for years to come. With QE2 coming to an end, inflation rising, immense pressure on the greenback to devalue and still no real plan to cut government debt, the risks are aplenty.

What He Said:

“If the U.S. housing market continues to fall apart, like I predict it will, the stock prices of major American banks that lend money to consumers to buy homes will come under pressure—these are the bank stocks I wouldn’t own.” Michael Lombardi in PROFIT CONFIDENTIAL, May 2, 2007. From May 2007 to November 2008, the Dow Jones U.S. Bank Index of the world’s largest bank stocks was down 65%.